When you think about it from a purely innocent and objective standpoint, it would seem as though estate planning is the easiest thing in the world. All you have to do is take assets that belonged to you and have them transferred to someone else after you pass away. How hard can this be? The reality is that it may not be that difficult to make this happen from a legal perspective, but the problem lies in the expenses that can be incurred while doing so.
Between the estate tax and gift tax, both of which carry a 35% rate, there are some obstacles there that can consume a very significant portion of your estate. There are a number of ways to respond, and one of these is the creation of a grantor retained annuity trust. The way it works is that you fund the trust, decide on a trust term, and name the beneficiary. You as the grantor then receive annuity payments from the trust throughout its term.
The act of funding the trust is considered to be a taxable gift, and the anticipated appreciation is accounted for by applying 120% of the federal midterm rate that was in place during the month the trust was created. But the amount of that gift is reduced by the interest that you retain in the trust, so to implement this strategy you “zero out” the trust and calculate your annuity payments to equal the entire value of the trust. If you do so effectively no gift tax will be due.
The trick is to fund the grantor retained annuity trust with appreciable assets. If the assets in the trust appreciate beyond the original estimated appreciation by the IRS, there will be a remainder left over at the end of the trust term. Ownership of this remainder will then be assumed by your beneficiary in a tax-free manner.
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